Much attention has been focused on the recent export performance of Australian wine, but the domestic market also remains critical to the health of the Australian wine industry. On the home front, producers face the dual problem of retailer consolidation and over-supply, writes Chris Brook-Carter, forcing smaller players particularly to think creatively about their route to market.

Although the Australian wine industry has transformed itself into a powerful export business and sales abroad have driven growth in the last 15 years, the domestic market remains one of the keys to the health of Australia's winemakers.

A mature and relatively small market, the growth rates cannot be expected to match those of the export market. However, growth on the Australian market has been steady enough over the last decade to be a source of cheer to the industry.

After a static period in wine consumption that ended around 1995, domestic consumption of wine has grown at around 3% to 8% per annum. Like exports, this growth has primarily come from the sale of bottled red wines. Per capita consumption of Australian wine has risen 3 percentage points to reach 21 litres in 2004.

However, in an assessment of the Australian wine Industry presented at the 2004 Wine Industry Outlook Conference, Australian Wine and Brandy Corporation information and analysis manager Laurie Stanford said: "A more conservative rate of growth is predicted for 2003-2004 to 2009-2010 - with the per capita consumption rate expected to grow by 2.2 percentage points to reach 23.2 litres per head."

When population growth is added into the equation, the domestic market for Australian wine is expected to grow by 7.4m cases by 2009-2010 to reach 54m cases. This represents compound annual growth of 2.5% over this period. "Red wine consumption, and in the large part bottled red wine, is expected to drive the growth," Stanford says.

However, underneath these largely positive figures, the picture is less rosy. Winemakers' profitability and margins continue to be squeezed by the twin threats of oversupply and growing retailer power. Between them, Coles Myer and Woolworths now control 75% of the packaged grocery market in Australia and 45% of the packaged liquor market. KPMG forecasts that the grocers will grow their share of the retail liquor market to 60% in the longer term, which will have implications for the fragmented wine industry.

There is certainly a feeling within the industry that they can no longer rely on the retailers to stock a diverse portfolio and push consumers to experiment. "There is no doubt the major players are very conscious of their shelf space, and they won't put anything on the shelf they don't see an opportunity to pull through," says David Woods, managing director of Hardy's Wine.

In such a tough environment, all producers suffer a squeeze on margins, but it is the smaller producers that suffer most because they have neither the marketing muscle to attract consumers nor the scale to satisfy the growing needs of the retailers. On top of all this, they lack the economies of scale to absorb the decreasing margins the oversupply is causing and the retailers are demanding.

"The biggest change [to the domestic market] has been the consolidation of the retail outlets. And I think that will continue to evolve," says AWBC CEO Sam Tolley. "What it does is match the requirements of those retailers to the requirements of the larger players and makes the route to market more challenging for smaller enterprises, so they have to be really innovative in their approach."

However, Tolley believes this evolution will make smaller producers rethink their route to market. "Consumers who want more choice than the supermarkets can offer will be receptive to new ways of interacting with the wine producers," he says. "That might mean that the remaining retail outlets will become more specialists and develop focus on smaller brands but also consumers may well be more likely to look at direct overtures through websites and direct mail."

There are still several hurdles to clear before that potential can be fulfilled, however. "I would say right now is probably the most difficult time, because the consolidation in the retail market has coincided with some surplus wine, which coincides with the export market being more complex," Tolley explains. "It will take them a little time to work through the solutions to that, plus many of them are very new, they may not have established reputations, or representations. So I think this is the most difficult time."

The fear is that the over-supply has changed the dynamic of the market for the worse for producers as discounting becomes embedded. The danger is demonstrated most graphically by the emergence of the cleanskin. A cleanskin is a bottle of wine sold without a label. They are typically bottles from bulk wine sold cheaply in dozen lots for home consumption.

There is more than a strong chance that cleanskins are only a function of the oversupply and that they will fade out of existence once that oversupply eases. But perhaps more concerning in the long term is the growth of the buyers-own-brand category, which is far less likely to fade away when the over-supply situation improves because of the stake the retailers have invested in the sector.

This feature is an extract from just-drinks.com's management briefing on the Australian wine industry which will be published next week.  For further information go to /membersclub/